I. The moratorium on the U.S.–China trade war is only the beginning of a higher level of “financial war” and “technology war.”
As I mentioned previously on this website, the U.S.–China trade war will be eased and put on hold. The U.S.–China trade war is ruinous to both sides, and Trump would not want such failure in U.S. trade ahead of the election in 2020. In my view, this is only a brief break during the war, and given the long-term strategic interests of the United States and the nature of Trump, it would not be surprising if they resume the war soon. We cannot regard this suspension as the end to the U.S.–China trade conflict. That is because the trade war is only the beginning of a low level of bargaining between the United States and China, and the gray rhino risks (very probable threats with a significantly negative impact(s) that are ignored), a higher level of “financial war” and “technological war,” are already here.
The long-term strategic objectives of the United States and China in the financial war are probably as follows.
The U.S. wants to maintain its dollar hegemony. On the other hand, China’s short-term goal is to globalize the yuan to make it a world currency for trade, investment and reserve. Furthermore, China wants to put the yuan on the same footing as the dollar as soon as possible, and eventually develop it into a world currency based on the decentralized and digitized economic power and trade volume of countries in the world.
II. Strategic development of offshore financial ecosystems
To globalize the yuan, they must establish an environment where the yuan can be exchanged freely with other currencies. Realizing such environment cuts both ways for the yuan, which is still in a weak position at the moment. If the yuan is globalized too fast, it will fall into the trap of the dollar hegemony, while if they fail in globalization, the yuan will never develop. Currently, Hong Kong is China’s main offshore financial channel, with about 60 to 70% of its inflows and outflows going through Hong Kong. As the single offshore financial channel, Hong Kong has become a major target for rivals. Behind the 2014 Occupy Central movements in Hong Kong and riots in this year lies the importance of Hong Kong as the offshore financial channel. It is also the reason why China is building an offshore financial ecosystem centered on Hong Kong but not tied to Hong Kong.
(i) China cannot give up the core position of Hong Kong as an offshore financial hub.
First, Hong Kong has institutional advantages. Adopting the “one country, two systems,” concept, Hong Kong is maintaining its capitalism. Under the capitalist system, Hong Kong plays an invaluable role as a key financial, trade, economic and maritime hub. Hong Kong has a sound legal system and a systematic, rigorous and efficient financial and economic supervisory mechanism which conforms to international practices. Furthermore, Hong Kong also has a flexible and efficient currency control system and a commercial bank and securities company system that enables appropriate, reasonable and fair competition. Over a long period of time, the definition, registration and trading of land, stocks, bonds and derivatives in Hong Kong have been guaranteed by complete legislation. The Hong Kong financial market has the advantages of low transaction costs, high transaction volume, high transaction speed, and flexible transactions, and industries related to the financial market are active there. It is unreasonable to compare the GDP of Hong Kong, which has a population of only about 7 million, with that of central cities with a population of about 10 million. Even so, the total value of trade of Hong Kong in 2018 was $1.2 trillion, double the total value of trade between China and the United States ($633.5 billion).
Second, Hong Kong is conveniently located. Placed in the heart of East Asia, Hong Kong is within four hours of flying to most cities in East Asia. It is also situated in the time zone between London and New York, and with the three financial centers, 24-hour operation of global finance is enabled. Behind Hong Kong is the PRC with its huge market potential. Hong Kong and the PRC have two different financial systems that can complement, help, and interact with one another.
Third, Hong Kong has a good business environment. Hong Kong’s tax system is simple and the tax rate is low. With its tax system, it is known as a paradise for small and medium-sized enterprises and for entrepreneurs. Hong Kong’s capital market is open, free and orderly and information is distributed swiftly there. Furthermore,s it is a hub for experts to get together from around the globe, it retains a perfect infrastructure and an independent legal system; Hong Kong is an ideal platform for PRC enterprises to advance overseas. The source and use of funds in the Hong Kong capital market are not limited to Hong Kong, and it is in fact a base via which international capital gives economic cooperation to China, observes investments and gains access to China. Hong Kong has long been a frontline base for China to develop its external financial relations and make its way into the international financial market.
(ii) With the backup of Hong Kong, Macau will become an offshore financial center.
In October 1999, Macau declared its Offshore Law and tried to develop the offshore financial industry by taking advantage of Hong Kong’s position as an international financial center, but it was not adopted because of different legal systems. However, they are actively proceeding with preparations. An official recently revealed that a plan for the Macau Stock Exchange has already been submitted to the central government, and the objective of it is to develop the Macau Stock Exchange into a Nasdaq-like market in offshore yuan. Macau’s per capita GDP is $86,000, far higher than that of Beijing, Shanghai, Guangzhou and Shenzhen.
Currently, there is no offshore financial market based on the Chinese yuan where small and medium-sized innovation enterprises can directly raise funds, but once the Macao Stock Exchange is established, this gap will be closed and it will stand on the same footing as Hong Kong. From a functional perspective, Hong Kong and Macau are both China’s offshore financial centers. Hong Kong is one of the four major financial centers in the world and is capable of handling all financial operations. And in Macau, China is trying to set up a stock exchange that enables the yuan to go overseas. It will also gradually take over a portion of Hong Kong’s financial business.
(iii) Shanghai, Shenzhen, Hainan, and 15 other free trade zones will gradually constitute the second and third layers of the overall offshore financial industry.
Since the establishment of the Shanghai Free Trade Experimental Zone in 2013, China’s free trade zones have increased to 18 locations: Shanghai, Guangdong, Tianjin, Fujian, Liaoning, Jiangsu, Henan, Hubei, Chongqing, Sichuan, Shanxi, Hainan, Shandong, Jiangsu, Guangxi, Hebei, Yunnan, and Heilongjiang. Like this, all coastal provinces are included in the free trade zones. In other words, China has succeeded in covering all its coastal areas with free trade zones. According to the authority and business classification given by the central government, the free trade zones can be broadly classified into three classes. The core layer is comprised of Macau and Hong Kong, and it is characterized by its one country, two systems concept. Hong Kong in particular, is right at the core. The second layer is provided with considerable authority from the central government, and is comprised of Shanghai, Shenzhen, and Hainan provinces, which are relatively open. The remaining areas constitute the third layer, and each has a distinct regional character. China’s free trade zones will expand further, and that demonstrates China’s willingness and determination to fully open its market.
III. Blockchain—tactical nuclear-missile-like technology in the U.S.–China financial war
According to a senior U.S. military analyst, China’s development of its offshore financial industry bypassing dollar trade will tear the world into two and create a “New Cold War” regime. Blockchain technology will be a new battlefield in the high-tech war between the two global superpowers. “America vs. China—China Challenging the Hegemony of Information, Finance and Advanced Technologies,” a documentary produced by Japan’s NHK, also objectively demonstrates the important role emerging technologies such as artificial intelligence and blockchains are playing in the U.S.–China trade war.
Why is the United States a superpower? It is because the United States possesses core technologies in areas such as information technology and aerospace technology, and is also can count on it dollar hegemony. The yen once had a chance to challenge this dollar hegemony, and the emergence of the euro after that also shook the dollar hegemony to a certain extent. However, neither of them could substantially disrupt dollar hegemony because of the precise attack by the United States. And now China is seen as the only country that can challenge U.S. hegemony in the next few years. Therefore, a financial and technological war between China and the United States is inevitable. Considering the U.S. sanctions against ZTE and Huawei amid the trade friction between them, the war between the U.S. and China over new scientific and technological innovations is already heating up.
(i) China is one step ahead of the U.S. in utilizing blockchains.
The United States is the world’s number one economic power and the lead runner in the most advanced technological industries in the world. However, it lags behind in the use of blockchains. The commercial availability of a technology verifies its effectiveness. Some advanced blockchain technologies in the United States are still not commercially available due to a lack of market demand. China, on the other hand, is one step ahead of the United States in the actual use of blockchain patented technologies because of its large market demand. China’s blockchain technology is seeking a different path from that of the United States. And in its actual use, it comes out ahead of the United States.
Look first at the financial sector, where blockchain technologies are most widely and heavily used. According to the “2017 Top 100 Global Blockchain Enterprise Invention Patent Ranking,” which is jointly published by intellectual property industry media IPRaily and incoPat Innovative Index Research Center, 49% of the companies ranked are in China and 33% are in the U.S. Among the top 10 companies, only 2 are U.S. companies, while 7 are Chinese. China is far ahead of the United States in commercializing blockchain technologies. In addition to large state-owned banks, the entry of Chinese Internet companies such as Alibaba, Baidu, Tencent, and JD.com in this market has also played the key role in the commercial utilization of blockchains in the financial sector. For example, in terms of the number of patent applications for blockchain technologies worldwide, Alibaba has filed 90 patent applications, and it is No. 1 in the world, surpassing IBM. These patents are primarily relevant to use in new retail, logistics, and traceability applications. “RubyChain,” which is developed by Shenzhen, China, offers operational mechanisms such as smart contracts, multi-chain parallelism, cross-chain agreements, storage of big data in blockchains, fragmented storage of non-blockchain application blocks, and fast migration of applications. They are well-balanced decentralized, scalable, and secure solutions that are said to be impossible to achieve in the public chain. Traditional and Internet companies are provided with convenient solutions for the import and use of blockchain technologies. As a result, blockchain applications can be developed as flexibly, quickly, cheaply, and one-stop as Web applications were, enabling full-scale commercial use of blockchains. In this way, China has already opened up to a new era of commercial use of blockchain technologies.
(ii) China’s blockchain research is taking a different path from that of the U.S.
If blockchains are one of the core economic and financial infrastructures, the one who can master the core technologies of blockchains will be the leader of the next generation in the information technology field. In order to avoid a repeat of the difficult situation in which Huawei and ZTE were sanctioned, the Chinese government and the market need to play their respective roles and develop their own policies that differ from those of the United States. The government must strengthen the financial system and financial management to protect the financial industry from system risks, and at the same time, reserve a certain amount of fault tolerance so that the market can remain effective and operate.
1. China will issue digital currency first based on its blockchain technologies.
Issuing a digital currency ahead of its competitor gives China an important opportunity to shock the global hegemony of the dollar currency. Under the rules of the current dollar hegemony competition, it is very difficult to globalize the Chinese yuan. In other words, the yuan will never overtake the dollar as long as it adheres to the current dynamic. It therefore has to change track. Issuing a digital currency first is the beginning of the globalization of the yuan. Legal digital currencies have the advantage of relying on a national sovereignty as traditional currencies do, and at the same time they have superiority as digital currencies. Even in the event of a failure of the local node, the funds are protected safely because transaction data of legal digital currencies based on blockchain technologies is distributed to other nodes of the network. Due to their characteristics as decentralized ledgers, which are connected to all networks, it becomes possible to avoid the risks associated with turmoil in international affairs and sanctions imposed by the major powers. With the back up of national sovereignties, they are very invulnerable to money laundering, hacking, counterfeiting, and tax evasion.
2. Blockchain technologies will allow China to break through the U.S. technological blockade and pave the way for an independent globalization of the yuan.
The United States is the pioneer in the Internet industry, and all IPv4 root name servers are managed by the U.S. government-owned ICANN (Internet Corporation for Assigned Names and Numbers). The ICANN manages Internet domain IPv4 root name servers, domain systems and Internet protocol addresses all over the world. There are only 13 clusters of IPv4 root name servers worldwide. Of them, 10 clusters are in the U.S., the 2 in Europe are in Sweden (I) and the Netherlands (K), and the 1 cluster in Asia is managed by Japan (M). Simply stated, the United States can shut down the Internet in certain areas. However, with the blockchain P2P-based communication mechanism, the control by ICANN is bypassed effectively. Furthermore, being characterized by security, confidentiality, open-source nature and globalization, blockchains are an effective means against technology blockades.
3. Differences in the development of blockchain industries between the United States and China
The United States and China have taken different paths due to differences in technology research, market size, and purpose of utilization. China’s main blockchain technology serves the real economy, exploiting markets in fields such as finance, medicine, justice, industry and media. In contrast, the United States focuses on trading of digital assets and the circulation of digital currency in the fields of games, gambling, and exchanges. It has been 10 years since the launch of blockchains, but the United States and China seem to be pursuing different policy goals. In terms of the commercial utilization of blockchains in recent years, we can see that the United States is just talking about it. In fact, native blockchain projects of JP Morgan, Facebook, and Microsoft are still under development, and there are few projects that can be used in the real economy. The U.S. is still making fruitless efforts for crypto currency in the use of blockchains. China’s blockchain projects, on the other hand, have been becoming a reality at an ever-increasing pace. The five major blockchain companies in China, Tencent, Alibaba, Xunlei, Baidu, and JD.com, as well as major companies such as Huawei, Wanxiang, ZhongAn, WeBank, and Ping An OneConnect, actually use a large number of blockchains. (For details, refer to the database of the Hulianmaibo Research Institute)
The realization of blockchain applications will advance China’s blockchain technologies. Xunlei Blockchain, Baidu Super Chain, Ant Blockchain, and Ping An OneConnect have developed their original blockchain technologies, and the performance, ease of use, and scalability of them have already reached the top level in the world. China has its own technology system. Forbes posted an article titled “Has the Chinese Blockchain Achieved Superiority in a Remarkable Manner?” which explains the global superiority of China’s blockchain technologies such as the Xunlei Blockchain. According to a database issued by Hulianmaibo Research Institute, the number of cases where blockchains were used in China during the first quarter of 2019 is 78, while the number in the U.S. is 26. Stimulated by cases where blockchains were used, the number of blockchain patent applications is also the largest in the world. According to statistics compiled by INNOJOY, the number of blockchain patent applications made in China is 7,639, while the U.S. has made only 1,551 applications. (Source: Hulianmaibo INNOJOY as of May 21, 2019)
In academic research, Chinese academia shifted from bitcoin research to blockchain research in 2016. Looking at the number of papers on blockchains in the EI database, 4 of the top 10 institutions are located in Europe, with the remainder in the United States, China, and Australia. As regards the number of papers on blockchains in CNKI’s domestic database, China is ranked first, and 3 of the top 10 institutions are state-owned banks in China. That means, the state-owned banks are placing great importance on studying blockchain technologies.
IV. Challenges facing blockchain innovation and their trends
(i) Challenges facing blockchain innovation
1. The framework of blockchain technologies itself is still immature.
Blockchain technology has only been around for 10 years, is still in its infancy compared to most other technologies, needs to improve scalability and efficiency, and needs a better business model. At this point, it is not yet ready for large-scale commercialization of decentralized applications (DAPP). At the same time, key technologies such as secret key encryption, smart contracts, shards, cross chains, and side chains, consensus-building algorithms and incentive designs such as DAG and DPOS are still in the pilot phase. Blockchains still need to improve their programs and codes.
2. Insufficient infrastructure and scale
There are many challenges to be addressed to ensure proper operation of blockchains, including synchronization optimization and real-time conversion. Recording information in a blockchain requires multiple participants and data synchronization. Currently, it takes time to construct hardware and software, and it is still difficult to realize a very large blockchain storage system. At the same time, to link the characteristics of blockchain technology to conventional industries, it is necessary to digitize, network, and intellectualize the conventional industries, but they cannot be achieved overnight. Realization of large-scale commercialization is still a long way off.
3. There is still room for improvement in the industry’s supervisory and management mechanism.
The decentralized, unmediated nature of blockchain makes it more difficult to oversee and manage the industry, and its technical nature makes it impossible for an individual or organization to own and manage it. Even if the law requires the founders of a blockchain organization or project to be jointly and severally liable for any foreseeable damage, they may not be able to identify the responsible party because the founders are anonymous or numerous.
(ii) Future trends in blockchains
1. The existing industry size of blockchain technology is huge and has maintained high growth rates.
Globally, the blockchain industry has enough momentum. Blockchain has already been used in wide areas; starting from the production of the first digital currency and mining machines, it has penetrated the financial service industry, supply chains, digital copyrights and food traceability. According to statistics compiled by the Chinese Institute of Electronics, the global blockchain industry size in 2017 was $5.2 billion, $7.8 billion in 2018, and it is expected to reach $12.0 billion in 2019. The average annual growth rate from 2013 to 2019 exceeds 60%.
In China, there is still room for the blockchain industry to rise. With continued investments by the Internet giants and the aggressive entry of emerging technology companies, and the huge potential market, the blockchain industry is ready to cover all phases of the current industries in 2 to 3 years. The hundreds of companies handling blockchain as their core businesses cover all of the multiple stages including upstream industry (e.g. hardware manufacturing, platform services, security services), downstream industry (e.g. industrial technology applications), and the investment and financing, media, and human resource services that support the development of industries.
2. There’s a lot of room for development in the blockchain industry.
The first step is to shift its marketing area from the financial industry to a variety of economic and social fields, large-scale marketing, and industrialization. A significant number of blockchain infrastructures are focusing on providing high-performance solutions at the commercial level while using shard, cross chain and side chain technologies. The U.S., Germany, the Netherlands and Singapore have already started to develop blockchain markets in multiple areas, including logistics tracking, manufacturing, energy payments, and charity management.
Now, the next-generation information technologies such as blockchains, big data, artificial intelligence and the Internet of Things are showing a tendency to systematically merge into one in a synergistic manner. The convergence of the physical and digital worlds will add value in use and in exchange to data and information based on reliable interconnection.
Finally, blockchains will construct a high-speed, intelligent, general-purpose, secure and unified next-generation information infrastructure. When the blockchains are used in areas such as electronic bills, asset trusts, logistics, food and drug safety traceability, and copyrights of digital content, different types of users will be provided with faster, safer, more compatible and more efficient services in the end.
China’s future blockchain industry will focus on basic theory and technology research. It will in particular, support R&D and application of key technologies such as blockchain storage, encryption, consensus building, and cross-chain technologies, promote interdisciplinary basic and applied research on blockchain technologies, and accelerate the construction of infrastructures. What China should place higher priority on is accelerating the convergence of 5G and blockchains, piloting R&D platforms such as national public chains and blockchains of industry groups, enhancing the efficiency and practical utility of blockchains, and increasing the application levels in industry. The Chinese government will further consider its policy for managing digital currency transactions. Then, I believe there will be a bright future for China’s digital currency and offshore financial business that are based on its blockchain technology.